How to Jump-Start the Clean-Tech Economy

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Executive Summary

Reprint: R0911D

Billions of dollars worldwide are pumped into the search for clean technology and renewable energy. So far, however, most investment has been in companies that are using conventional business models to fit new technologies into existing systems. A far better approach, say Johnson and Suskewicz, is to create whole new systems.

The authors propose a framework for thinking about clean tech that consists of four interdependent components: an enabling technology, an innovative business model, a careful market-adoption strategy, and a favorable government policy.

Two recent experiments show how this framework can be applied: Better Place, founded by the software executive Shai Agassi, has a network of battery-recharging and -switching stations to support its electric cars and a business model based on selling electricity (miles) rather than vehicles. It has a foothold market in Israel, where gas-powered cars are taxed far higher than electric ones.

Masdar City, now under construction in Abu Dhabi, will be a carbon-neutral incubator of clean technologies, supported by the investment, manufacturing, strategy, and academic units of a government initiative. The city is itself a foothold market and will benefit from government subsidies, “free zone” status, and favorable regulations. Both enterprises provide hope for supplanting the oil-based economy.

The Idea in Brief

• Most clean-tech efforts approach the challenge of transforming the energy industry as primarily technological, in the belief that new technologies can be bolted onto existing systems.

• Focusing on technologies rather than on systems has slowed clean-tech adoption. Governments and businesses must balance four components: an enabling technological system; an innovative, customized business model; a market-adoption strategy that assures a foothold; and a favorable government policy.

• Two intriguing systemic experiments are under way: Better Place, which is building a competitive electric-car network; and Masdar, established by the government of Abu Dhabi to create a clean-tech sector.

What will it take to transition from a fossil-fuel economy to a “clean-tech” economy powered by renewable energy? Silicon Valley is teeming with new projects in this field, and bold policy proposals are flying around inside the Beltway. The Obama administration has pledged more than $100 billion for sustainable technologies; China plans to spend $200 billion, and the G-20 industrialized nations some $400 billion. Venture capitalists around the world have pumped in excess of $20 billion into clean-tech companies since 2005.

So far, the bulk of investment has been in companies using conventional business models in an effort to fit clean technologies into existing systems. Sadly, history shows that this rarely works. Start-ups predictably struggle when competing head-on against incumbents in established markets. Disruptive market forces could over many years enable clean technologies to supplant fossil fuels the way the PC replaced the mainframe. ( See the sidebar “An Evolutionary Approach to Clean-Tech Adoption.”) But we won’t have to wait that long if we can deliberately effect a wholesale shift in our energy infrastructure.

An Evolutionary Approach to Clean-Tech Adoption

Competing head-on with fossil-fuel-based energy is exceptionally difficult. A century of investment and innovation has yielded a comprehensive network of energy production and distribution that powers our homes, cars, and factories more conveniently, efficiently, and cost-effectively than anything else right now. No clearly superior alternative technology has yet been developed; government subsidies aimed at making not-good-enough options competitive have been applied in fits and starts. In any event, no alternative will be viable over time if it can succeed only on an artificially created playing field maintained by permanent subsidies.

Not-good-enough technologies take root in markets all the time; the personal computer couldn’t begin to substitute for mini and mainframe computers when it was introduced. But as improvements evolved and were tested in the less-demanding home market, PCs eventually became a better alternative in the mainstream business market.

Some clean technologies are following a similar path, starting out as small, basic applications—such as neighborhood electric vehicles in developed countries and off-the-grid solar power installations in the developing world—that may improve and become more competitive in wider markets. We applaud all these efforts. They are certainly smarter than simply throwing large sums of money at the technology of the month.

To be sure, this is an ambitious goal that requires thinking on a grand scale. The key, we believe, is to understand that in a major infrastructural shift, technologies don’t replace other technologies. Rather, systems replace systems.

Edison’s Insight

Thomas Edison grasped the systemic nature of technological transformation a century ago, when he introduced the electric lightbulb. He realized that the technology he envisioned—no matter how innovative—couldn’t by itself sweep aside the kerosene-based lighting industry. Instead of asking how he could solve the technical problem of inventing a lightbulb, Edison asked how he could get consumers to switch from kerosene to electricity. He understood that despite the many advantages of electric light, it would replace kerosene only if it had its own, economically competitive network.

So, while scores of people worldwide worked on inventing a lightbulb, Edison conceived a fully operational system. His technical platform included generators, meters, transmission lines, and substations, and he mapped out both how they would interact technically and how they would combine in a profitable business. It had been widely assumed, for instance, that low-resistance filaments were most appropriate for lightbulbs, because they minimized the amount of energy lost as heat. But Edison determined that to make electric light economically competitive with kerosene lamps, he would have to limit the amount of costly copper used in transmission. Thus he’d need a high enough voltage to maintain current within a narrow wire—which meant a high-resistance filament in the lightbulb itself. Edison’s search for a lamp filament “was conditioned by cost analyses,” the science historian Thomas Hughes wrote in the journal Technology and Culture. “In his notebooks pages of economic calculation are mixed with pages reporting experimental data, and among these one encounters reasoned explication and hypothesis formulation based on science—the web is seamless. His originality and impact lie…in this synthesis.”

Edison tested his concept in a pilot project at his Menlo Park facility and then launched it commercially on a small scale in Lower Manhattan, a favorable foothold market because the buildings were close together and filled with potentially enthusiastic customers: Wall Street firms that were eager to be on the technological cutting edge and that had employees who worked long into the night. It was not coincidental that he was demonstrating his system to the very people who could fund its expansion. He also used his public standing to acquire regulatory support—for example, to get the needed permits despite opposition from the lamplighters’ union.

Others had designed decent lightbulbs, but without coherent commercial systems their inventions were for naught. We should be looking for the Thomas Edisons of clean tech.

A Transformation Framework

Many of the difficulties of clean-tech adoption can be traced to the fundamental error of focusing on parts rather than on the whole. Like Edison’s, our framework for thinking about new systems consists of four interdependent and mutually reinforcing components: an enabling technology, an innovative business model, a careful market-adoption strategy, and a favorable government policy. The clean-tech discourse has given far too little attention to the importance of business models and market adoption and even less to coordinating all four components into a coherent whole. Let’s look at each of the four in turn.

An enabling technology.

Systemic shifts are often instigated by the emergence of new technologies. The invention of the steam engine catalyzed the era of the railroad; the creation of the microprocessor launched the information age. But the real impact of these technologies was felt only after systems had evolved around them. The invention of the internal combustion engine gave rise to the automobile, but it was Henry Ford’s production process and the construction of roads, gas stations, and so on that ushered in the automobile age, dooming the horse and carriage. As Edison understood, for such advances to become viable, they must belong to complex, interdependent systems whose components work together in specialized ways. Edison didn’t try to plug his lightbulb into the kerosene system, or even to adapt it to the contemporary method of electricity generation, in which each location relied on its own power source. He knew that he needed to envision an alternative system, build it out of both old and new technologies, and properly integrate it from the ground up.

An innovative business model.

As we’ve written in these pages and elsewhere, successful commercialization depends on combining an offering that solves a real customer problem with a business model whereby the company can deliver that offering at a profit. The business model consists of the customer value proposition, the profit formula, and the key resources and processes the company must combine to deliver the offering. The unique way in which these elements are integrated to create value for both the customer and the company is the essence of competitive advantage. (For a more complete description of the business model, see Mark W. Johnson, Clayton M. Christensen, and Henning Kagermann, “Reinventing Your Business Model,” HBR December 2008.)

New technological paradigms require business models designed specifically for them. Consider Google: Countless dot-coms attempted to fashion new businesses on the internet, but many of them simply replicated traditional media business models, such as those built on display advertising, and, of course, many of them had no business model. Google, however, paired its advanced search technology with a fundamentally different business model—advertiser-paid search—and became one of the fastest-growing and most profitable companies in the world.

Innovative business models can have a devastating effect on incumbents. The oil and automotive business models, for instance, built as they are around fuel, parts, and maintenance for the complex internal combustion engine, could be undermined by a new model that takes advantage of simpler, streamlined electric engines. The utility industry’s volume-based profit formula—the more power consumed, the higher the profit—may well fall apart as competitors devise ways to capitalize on the smart grid’s ability to make power distribution dramatically more efficient.

A careful market-adoption strategy.

It is in a relatively simple and isolated business environment that key assumptions about integrating the technologies and the business model will be tested, adjustments to the system will be made, and concepts will be demonstrated to skeptical but crucial stakeholders. Clean-tech systems, like the systems they’re intended to replace, will be complicated; how best to integrate their parts won’t be clear at the outset. Edison ran his grid on direct current, going to great (and futile) lengths to persuade the public that alternating current (which could be transmitted over long distances far more easily, using transformers) was unsafe. Even he, the system’s inventor, was unable to see how all the parts would eventually fit together.

The most practical and effective course in situations of high ambiguity is to take an emergent approach—that is, to make your best predictions about what will work and then focus on finding creative, quick, and inexpensive ways to test the assumptions underlying those predictions. This is good advice for new ventures in general, and it applies to systemic transformations as well, even though they often require big investments just to get started. The aim should be to make the least possible investment in the smallest possible experiments to preserve the minimum scale needed to demonstrate the concept.

Accordingly, nascent clean-tech offerings have to incubate outside demanding, competitive markets—in foothold markets, where the value proposition offered by even early-stage technologies and business models is so great that customers are willing to overlook their shortcomings.

A favorable government policy.

Governments have long been central in advancing the development of next-generation technologies. But they shouldn’t support market-ready technologies unless it’s clear that they can be delivered profitably. Otherwise, situations like the corn ethanol bubble of the past few years will be all too common. Government support is most effective when it’s directed not just at nascent technologies but also at nascent business models.

In addition to funding new models, policy makers must amend regulations that inhibit their development—such as those against driving electric vehicles in certain neighborhoods. And because it’s impossible to predict which new technologies will win out, policy makers should use limited regulatory experiments to generate political momentum.

That’s the approach officials took in Stockholm in their efforts to alleviate traffic congestion. Previously, certain crowded cities had tried to reduce traffic and pollution by instituting variable taxes on cars entering busy districts during peak times. The taxes were highly controversial, so it’s not surprising that before Stockholm instituted a congestion-pricing tax, some 80% of its residents told pollsters they disapproved of the idea.

Government support is most effective when it’s directed not just at nascent technologies but also at nascent business models.

In 2006 the city government ran a small-scale seven-month trial in one neighborhood, during which officials measured traffic and pollution levels and tested various taxation schemes. The residents of the district were surprised by the effect the program had on their daily lives: Their streets were less busy, it was easier to get places on time, and the air was noticeably fresher. Data backed up these observations, and positive reports about the pilot program abounded. Public opinion flipped, and congestion pricing for the whole city passed in a referendum by 52% to 45%. Since being fully deployed, the program has cut traffic by as much as 50% and air pollution by 14%.

Although it may be natural to think that systemic transitions start with a technology that gives rise to an innovative business model, or that government must step in last, the four components of the framework needn’t be conceived in any particular order. But whatever way the process unfolds, the first step should be to envision a system that integrates all four. Then the system’s viability should be tested, refined, and demonstrated in the real world.

Systemic transformation is hard. It’s the biggest of big bets, involving many interdependencies and more than a little luck. So it’s not surprising that there aren’t very many examples of it and that those that exist are easy to criticize. But focusing only on the risks and the shortcomings of individual attempts will blind us to the lessons we can learn from pioneering efforts to create an alternative to the carbon economy. That’s why we went to investigate two of them firsthand: Better Place, the much-publicized company Shai Agassi launched to create a viable electric-automobile network, and Masdar, the organization set up by the government of Abu Dhabi to, among other things, build a city run entirely on clean technologies. To our knowledge, no one in the world is doing any better at taking a systemic approach.

Getting to a Better Place

Many readers will be familiar with Better Place. But studying it through a systemic lens, as we did in a series of executive interviews and a visit to pilot locations outside Tel Aviv, offers fresh insight. In 2005 Agassi was a top executive at SAP when he asked himself a daring question: How could he get an entire country, such as his native Israel, off oil? The answer led him to leave his perch atop the software world and become a clean-tech entrepreneur. Throughout his career Agassi had built software systems. He immediately realized that the oil dilemma was a systemic problem, and that the electric car was the key to displacing oil. But electric vehicles had been around since the nineteenth century and had never been able to compete with the convenience and relatively lower cost of gasoline-powered cars. Drivers expected to be able to travel hundreds of miles before needing to refuel—and to refuel quickly.

A Systemic Model

Better Place, Shai Agassi’s start-up electric-vehicle services company in Israel, aims to make electric transport as easy, reliable, and affordable as gas-powered cars.

Market Adoption

Israel, given its small size, desire to minimize dependence on oil, and innovative, technology-focused economy, was a natural foothold market in which enough cars could be sold fast enough to make the network pay off.

Technology

Automated switching stations can swap a depleted battery for a fully charged one in less time than it takes to fill a tank with gas.

Charge spots in business and residential areas will allow drivers to recharge while parked.

Proprietary software will monitor batteries and direct drivers to the nearest charge spot or switching station when levels are low.

Business Model

The batteries belong to Better Place, which sells miles (electricity), and makes its profit on the difference between the cost per mile for gas and the much lower cost of electricity.

Rebates from Better Place to electric-car buyers—like handset subsidies from cell phone carriers—will provide an incentive to switch away from gas.

Policy

Import tax in Israel has dropped to 10% for electric vehicles while rising to 72% for gas-powered cars.

Technology.

The battery is the primary impediment to electric transport. Today, batteries that can take a car as far as a tank of gas can are too big, heavy, expensive, and slow to recharge. But instead of focusing on how to make batteries work in the existing system, Agassi asked what new system would be needed to make them as convenient, effective, and affordable as gasoline.

He realized that divorcing the battery from the car would overcome many of the technological constraints. The Chevy Volt, which will go 40 miles between charges, uses only 50% of its battery capacity to preserve the 10-year life span of its fully warranted battery. If a company were to sell cars but retain ownership of their batteries, it would be able to squeeze more energy from each charge. Better Place’s battery can go 100 miles between charges, because the company need not provide a full 10-year warranty.

But merely improving the battery doesn’t address the convenience problem—that requires an entirely new technological system. Better Place’s solution: an extensive network of easy-to-use charge spots where people can park near their homes and workplaces; automated switching stations that rapidly replace depleted batteries with fully charged ones; and a proprietary software system called AutOS that tracks battery life and directs users to charge spots or switching stations well before their batteries run out of juice.

Better Place’s network is designed to make driving electric cars as easy as possible. It is also designed to overcome a subtler but equally significant hurdle to electric-car adoption: grid capacity. Critics of electric cars have long pointed out that if all commuters plugged in their cars at the end of the workday, the grid would be overtaxed. Better Place is preempting this problem: AutOS will monitor and manage when each car draws electricity, rather than automatically recharging it as soon as it’s plugged in. Thus the company can engineer its overall power draw to occur when power is cheapest and stabilize the grid during times of peak demand. This capability—known as demand management—is enormously attractive to utilities, because it helps them balance their loads.

Business Model.

As this solution was taking shape, Agassi sought the advice of President Bill Clinton, who pointed out that the electric car needed to compete not just for new-car buyers but for the far larger pool of used-car buyers. Clinton wondered if Agassi could lower the cost of the cars enough to preempt all gasoline alternatives. Could he, say, make the cars free?

Separating ownership of the $10,000 battery from ownership of the car could lower the car’s cost substantially but not eliminate it. What would make it worth a company’s while to give cars away? A new business model began to take shape: Agassi would sell electricity—miles—rather than cars.

This, he realized, is essentially what cell phone carriers do: They build the network and heavily subsidize the hardware—the phones—while customers pay for minutes of talk time. Better Place would peg the price of miles to that of gas, using the margin between the cost of gas and the much lower cost of electricity to provide rebates that would make electric vehicles significantly cheaper than comparable gas-fueled cars. In fact, the company could sell electric miles the way cell phone carriers sell minutes—with a range of plans, from pay-as-you-go to fixed-price contracts.

Market.

Agassi needed to find a foothold market in which enough cars could be sold fast enough to make the network pay off. It had to be a contained setting to make comprehensive battery recharging and swapping relatively easy to provide.

Early on he had shared his ideas with Shimon Peres, then the vice premier of Israel, and won a champion. Given its small size, strategic interest in minimizing the political power of oil, and innovative, technology-focused economy, Israel was a natural fit for Better Place. Few of its residents drive more than 20 miles at a time, and cars seldom cross the border. “It’s a perfect transportation island,” Agassi likes to joke. “If your car has left the country, it’s been stolen.” Furthermore, 60% of new cars in Israel are bought by corporate customers for their employees. More than 50 companies in Israel have already signed up to convert portions of their fleets to the Better Place network.

Policy.

Peres had already devised a fairly simple public-policy initiative to support the adoption of electric cars in Israel. New cars had been subject to a 50% import tax; the tax on gas-powered cars would rise to 72%, while electric vehicles would be charged only 10%. The tax on gas cars is slated to increase over time, speeding the shift to an all-electric fleet. In addition to creating these incentives, Peres introduced Agassi to leading industrialists in Israel and Europe, one of whom became a critical partner in the venture: Carlos Ghosn, the CEO of Renault-Nissan.

That’s policy on the national level; Better Place has learned that policy on the local level requires a lot more legwork. The company has had to approach municipalities one by one for permits to install charge spots. The hope is that a federal edict, or the credibility earned by a successful demonstration on the local level, will streamline this process.

As you read this, Better Place is blanketing Israel with charge spots. It has successfully tested an automated system in Japan that can swap out a spent battery for a new one in less than two minutes, and it is using conventional cars to test its GPS-based navigation software. Systemwide tests are set to begin in 2010, followed by a carefully staged rollout in 2011.

MASDAR CITY, a freestanding carbon-neutral development in the Abu Dhabi desert, was begun in February 2008. Ultimately it will house 1,500 clean-tech companies and 40,000 residents.

Better Place’s destiny is far from clear, of course. Critics accuse Agassi of being too ambitious. And indeed there’s a lot one could take issue with: For instance, people have pointed out that the switching stations require the batteries and battery placement in the cars to be highly standardized, which would restrict styling options for carmakers. One might also argue with the scale of the trial market. But what we do not take issue with is the coordinated approach. It’s essential to work at the systemic level and to engage all four components of transformation from the beginning. Better Place is a compelling demonstration of how individual companies might go about effecting sweeping change.

Thinking on a Grand Scale

Suppose you had far more money, political control, and natural resources at your disposal than Agassi has. How might you approach clean-tech transformation? We went to Abu Dhabi to find out. One of the United Arab Emirates, Abu Dhabi sits on 9% of the world’s oil. In 2006 its leadership launched the Masdar Initiative to focus on building a clean-tech sector, with the aim of diversifying the emirate’s economy, offsetting its contributions to global warming, and making its growth more sustainable by leveraging its energy expertise and its abundant sunlight. It was an ambitious charter, and Masdar came up with a suitably ambitious plan: It would build a carbon-neutral city—the world’s first—to incubate clean technologies. The project broke ground in February 2008.

Masdar’s business model is an exercise in the deliberate creation of a clean-tech cluster.

Technology.

Masdar City will use 100% renewable energy, much of it generated on-site. It will have no cars; instead, an all-electric, automated personal rapid transit system will ferry people around. A comprehensive network of vacuum tubes will carry all garbage to a central site, where it will be sorted to be reused, composted, or burned for energy.

The entire city will sit on concrete pillars seven meters off the ground, providing easily accessible space for basic infrastructure—sewers, electrical systems, and so forth. The streets and buildings are designed to funnel hot desert air upward, creating breezes to cool the city and concentrating heat in wind tunnels to be sent to the on-site desalinization system. This synergistic design will reduce the energy needed for air-conditioning and the production of fresh water. All in all, Masdar City will be a living laboratory for the integration of an impressive array of clean technologies.

Business Model.

The Masdar Initiative consists of five distinct units, one of which is developing the city. An investment arm takes stakes in promising clean-tech start-ups and projects around the world, such as Solyndra, an innovative U.S.-based thin-film solar company, and London Array, a gigantic wind farm going up in the UK. An industries unit manufactures clean-tech equipment; its first solar-panel factory recently opened in Germany. A carbon strategies unit develops systems and solutions to deal with global-warming pollution and is working to reduce the carbon generated during oil extraction in Nigeria. The last unit is the world’s first clean-tech-focused university: the MIT-affiliated Masdar Institute of Science and Technology, which enrolled its first 92 students, from 22 nations, this fall and will relocate from temporary quarters to its Masdar City site in 2010.

Masdar City will be a laboratory for clean technologies, including driverless, personal electric transporters.

The units will share insights and provide mutual support; together, they promise considerable synergies. The companies Masdar invests in, for example, will have an inside track on bids to supply Masdar City, office space in the city, and access to the university’s resources. “We will smooth out the technology development process,” Dr. Tariq Ali, the vice president of research and industry relations at the Masdar Institute, told us. “Our units cover each stage of technology development, from basic research to implementation at scale.”

But more significant in our view is what Masdar’s parts add up to: a business model not so much for a company as for a country—an exercise in the deliberate creation of a clean-tech cluster. Michael Porter, of Harvard Business School, defines clusters as geographic concentrations of interconnected companies and institutions in a particular field that give competitive advantage to a region by exploiting its unique resources. Clusters feed on their own success, creating a virtuous cycle. As Masdar’s university and other units get off the ground, they will attract more clean-tech companies to the city, increasing occupancy for the property development unit while providing easy access to top technologies and potential partners for the investment and industries arms. General Electric has already signed on as an anchor tenant. The first commercial occupants are set to move in by 2013, and the city expects within a decade to be home to Masdar’s headquarters, the International Renewable Energy Agency, 1,500 clean-tech companies, and 40,000 permanent residents.

Market.

Masdar is wisely taking a measured approach to implementation. It has installed a 10-megawatt solar power plant, and it is developing the city in modules, one neighborhood at a time; the first will be completed by the end of 2009. As each one is constructed, successes and mistakes will be carefully catalogued for reference in building the next. “We have learned a tremendous amount already,” says Khaled Awad, the man in charge of developing the city. “The second neighborhood will cost significantly less than the first did and be built much quicker.” As new technologies are deployed and integrated, problems with implementation can be identified and fixed. This process is occurring irregularly around the world; Masdar is concentrating and accelerating it.

The city’s streets and buildings will be designed to funnel hot desert air upward, helping to drive desalinization systems and create cooling breezes.

In effect, Masdar City is its own sheltered end market. Given a chance to mature with minimal barriers to implementation and adoption, clean-energy technologies and business models can become viable options both for building projects in the developing world and for retrofits in the developed world.

Policy.

Clearly, as a government-owned entity, Masdar is in a position to enjoy advantages that can’t be matched in countries with less political will, on a scale not possible in the private sector. Although independently managed, it was founded with $15 billion of government money. Abu Dhabi granted Masdar the land the city is being built on, made the city a “free zone” in which foreign companies can avoid otherwise onerous native-ownership requirements, and put in place policies to encourage entrepreneurship and innovation. In fact, Abu Dhabi views Masdar as its clean-energy-policy think tank and is working with it to craft favorable regulations.

It may be tempting to dismiss this model as impractical in more-liberal economies with more-democratic governments. But consider that the $100 billion President Obama and Congress are contemplating to promote clean tech in the United States is more than six times as much as what Abu Dhabi is investing in Masdar. The U.S. government sets up free-trade zones in inner cities; it might also seed or encourage clean-tech clusters in the United States with some of that $100 billion. Given the imperative to work at a systemic level, the Masdar approach—delving deeply into a confined but comprehensive project—is more promising than shallow bets across a broad landscape.

Masdar’s clean-tech ambitions are already having an effect beyond the walls of its construction site. In an effort to reach its goal of carbon neutrality, the development unit has asked suppliers to reduce their carbon footprints. This request has reverberated throughout the supply chain, motivating scores of companies in the Middle East and elsewhere to cut their carbon emissions and make their operations more sustainable.• • •

Will Masdar be successful? Just as with Better Place, it’s too early to say. In our view, the value of these enterprises lies as much in their demonstration of what might or might not work in the pursuit of a more sustainable economy as in their individual fortunes. By taking a systemic approach, identifying and wrestling with key assumptions, and discovering new ways to combine key elements into a whole, both companies are accelerating the development of viable clean technologies. And despite the scope of their efforts, they are actually reducing risks and costs while increasing efficiency. Their new systems are already taking physical shape. Will they become competitive enough to supplant significant parts of the oil-based economy? It’s easy to be skeptical—but we think it’s wiser to see them as models that the rest of the world should study.

A version of this article appeared in the November 2009 issue of Harvard Business Review.